Asymmetrical Information

Your last sentence should read "This would not be a problem, of course, if most journalists had more than a cursory knowlege of anything."

Most journalists are as economically illiterate as their average reader.

The world would be a better place if, in lieu of one of the usual time-honored dregs of the Western canon (Plato's Republic would be my choice), every college student was required to read the essay in which Bastiat introduced the famous broken window analogy. A ringing defense of economic freedom, and for all I know the last piece of worthwhile thought to emanate from France.

Yeah, GDP is like a cash flow statement. What's missing is the balance sheet.

Echoing fling93 - we need a GDV (Gross Domestic Value) number, to go along with the GDP.

Secondly, in the sense that disasters cause people to spend more on necessities and/or "hard" goods and defer on things like entertainment and education and such, it may have a positive effect on consumption/purchase of durable goods. Which, as any good journalist would tell you are so much more "real" and "valuable" than those other things.

Wow, if a hurricane helps out think how much a nuclear war could do!

To many think about economics in terms of money changing hands. Economics is really about resources and information. Money is just a proxy measurement that represents the latter two factors only imperfectly.

I guess we pay so much attention to the movement of money, even when that movement produces not net gain to anybody, because (1) it is easy to measure and (2) we al want some.

Uh, Jane, the "broken windows theory," as promulgated by James Q. Wilson, has to do with policing--pay attention to the small stuff, and you won't have criminals who move on to bigger stuff. Make property owners fix broken windows, and in the long run, you'll have less theft.

But don't most people refer to a flow when they refer to "the economy?"

Or, to be more precise, don't they really mean "unemployment?" It's not what economists mean, but it's what most people really think matters.

Don't get me wrong. I didn't read the "good for the economy" stories about the Tusnami, but they would cause me to wince, too, and wish for a better explanation of the relationship between well being and the unemployment rate.

cc, there are two theories using broken windows as the illustration. You've described one; Jane was talking about the other.

GDP doesn't even measure all of the flows, as I discuss here:

http://libertycorner.blogspot.com/2005/01/century-of-progress.html

As for the stocks, who knows? Prices are only marginal valuations.

Maybe if economists spent more time trying to explain themselves, rather than self-congratulating, the average journalist would have half a chance.

The linked article was horrible from the get-go, for anyone who didn't go check it out. A teaser: the headline was "Tsunami a blessing in disguise for Sri Lanka's economy." Holy cow. It's like telling a family who just suffered the death of a child, "Consider yourselves lucky - at least you didn't have to go through the teenage years." Of all the appalling, insensitive -

I believe you're right cc, the broken window thing was started by James Wilson which is sort of another verion of the Camel's Nose in the tent analogy. Let 'em get away with breaking a window and next thing you'll know your street will become an open drug market.

But Jane's point is right too, we often hear about diasters causing economic growth. This is just an artifice of the numbers.

Suppose GNP this year is $100. Next year some horrible diaster hits and GNP is reduced to $80. The year after that the economy recovers to its original state. Well going from $80 to $100 represents growth of 25%! Pretty fantastic as far as typical GDP growth goes but you are really just getting back to where you were three years ago.

Well, there are physical analogues to the 'Broken Window Theory', but their correspondence to economics is pretty uncertain. For example, in simulated annealing the Metropolis Algorithm proceeds by always taking an improvement in the quality function, and *sometimes* taking a decrease in the quality function. This gives much better performance than *never* accepting a decrease. The temporary setbacks allow exploration of a larger search space than otherwise possible.

If I could think of a situation where this might apply, it is something where the economy is so moribund that any change at all could lead to the exploration of promising new possibilities, if the possibilities were permitted to exist. For example, if North Korea had an earthquake, and the earthquake caused a radical restructuring of the economy along capitalist lines....

Naaahh.

I would start economics education earlier than college, like a little bit all through secondary education. I got 1/2 a semester and didn't learn jack. Maybe the teaching profession deep down isn't reallly into it.

Ron, economists frequently try to explain themselves. Paul Krugman, for example, was a great popularizer of "the dismal science" in the days before he turned into a mouth-foaming Bush hater so deranged he makes Daily Kos look centrist.

The problem is that many things about economics are, on the surface, counter-intuitive. It actually takes some work to step through all the logical consequences of a particular economic policy and accurately evaluate whether it's a good idea or a bad idea. Journalists, as a general rule, aren't interested in doing the work -- and they certainly don't think their readers want to.

Boonton and cc:

You are both confusing James Q. Wilson's Broken Window Theory with Bastiat's Broken Window Fallacy. One is a theory, the other a fallacy and they have little in common. I suggest you click the link Jane provided and read what has to be one of the most important eonomic essays ever written, at least as far as explaining the true purpose of economics.

GDP is not much good as a measure of well-being because it measures output flow without reference to why those outputs are needed. That is, the USA had a fantastic GDP in 1943, but more than half of that was military production, which was mostly getting shipped overseas and blown up. Spending our national wealth this way was greatly preferable to the alternatives (which probably would have eventually involved lots of stuff getting blown up over here instead of over there), but it wasn't any way to accumulate wealth.

A good point markm but there isn't any easy way to differentiate 'good GDP' from 'bad GDP'. The other classic example would be increased crime causing us to spend more on street lights and car alarms. This would register as an increase in GDP but it's obvious we'd be better off if we didn't have to do it.

time for a social-economic welfare indicator that politicians are willing to use. but then, you would also have to factor in pollution problems, the value of ripping up non-renewable natural resources and other stuff, house-work, private child-rearing, etc. and that will lead to all kinds of different policy items becoming more visible and needing fixin'. do we really want to handle those sorts of problems? i mean, really...

See also Chap. 2 of Henry Hazlitt's nifty liitle book, ECONOMICS IN ONE LESSON (1946), "The Broken Window":

"A young hoodlum, say, heaves a brick through the window of a baker’s shop. The shopkeeper runs out furious, but the boy is gone. A crowd gathers, and begins to stare with quiet satisfaction at the gaping hole in the window and the shattered glass over the bread and pies. After a while the crowd feels the need for philosophic reflection. And several of its members are almost certain to remind each other or the baker that, after all, the misfortune has its bright side. It will make business for some glazier... [But] Instead of [the shopkeeper] having a window and $250, he now has merely a window. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window or the suit. If we think of him as a part of the community, the community has lost a new suit that might otherwise have come into being, and is just that much poorer."

Hazlitt was recycling Bastiat, of course. Both men were writing before, and making a different point, than the estimable Prof. Wilson.

Why was the economy so much better after WWII than before? I had always heard that it was becuase of the massive spending in war and subsequent rebuilding that got the economy running again. That never made sense to me, for exactly the reasons explained by the broken window falacy. But it is a fact that the economy was better after than before, and I have never heard other explainations. Does anyone here know of one?

I've heard similar economic idiocy from a Canadian Green (I'm sure non-Canadians have proposed this, but this particular one is a Canuckistani).

The idea was that massive environmental regulations requiring reworking pretty much the entire economy, increased energy costs, and the like, would be paid for by the "green boom" caused by having to buy all that new equipment to comply.

This would have had at least a tiny amount of plausibility if the new "green" technologies were even conceptually to be more efficient (in terms of output per cost of input), but he was perfectly willing to admit that they wouldn't actually reduce the cost of production a bit.

And he was surprised that I didn't believe the "green boom" would solve all the problems of, for instance, accepting the Kyoto accords.

Why is it so hard the average Joe to know about the hidden costs of some touted economic activity?
People certainly understand it on the personal level - you spend $5 for latte, you forego spending the $5 on a pizza. Yet, time after time, we read that the $100,000,000 spent on, say, a new baseball stadium, will create XXX new jobs for the region. Yet what about the XXX jobs lost in all the pizza parlors, coffee shops, book stores, etc. where the fans used to spend the $100,000,000 they now spend to attend ball games.

Jane points out "...since GDP measures only flows, rather than stocks...". Wouldn't this also possibly be a good reason to question the deficit as percentage of GDP metric? Given that much of our current debt is being held outside of the U.S. it seems that it might be prudent to worry a bit more about the absolute dollar amount than some people think.

Another example of this mode of thought was provided by someone (the name Robert Wilson rings a bell) when he argued that the gap in American/W European GDP per head was mostly due to things like: more air-conditioning in America, because of its extreme climate; more automobile use, because America is so spread out and has limited public transportation; more prisons, because prison sentences in America tend to be much longer than in Europe; etc. That extra activity may add to GDP, but does it really add to welfare? (And when you add the longer holidays that Europeans take, the comparison in welfare is no doubt even more favourable to Europe).

Colour me slightly confused. In the example, the person has spent money on a new window instead of leaving it in the savings bank.

How is this different from foreign governments being told that they should spur domestic consumption in order to lower their dependency on exports to the US (and perhaps increase imports from the US)?

Aside from the loss of satisfaction (buying new glass rather than buying a new suit), from an economics point of view doesn't a disaster mean simply a transfer from savings into consumption? Isn't this exactly what large numbers of economists are saying is required of non-American (especially Asian) nations?

Tom: If someone took $250 out of their savings to replace a broken window, that's money that isn't there for the bank to loan to someone starting or expanding a business, buying a house, etc.

Decnavda -

Wars may lead to increased growth afterwards as the economy struggles to recover, but that's another example of the difference between the flow (GDP) and the level of overall wealth.

The best example of this is China's economic growth - people sometimes say that the US should learn from China, since it's outgrowing us in terms of the rate of change. But part of China's secret was the Great Leap and Cultural Revolution - if you pound the economy into the ground and fall far, far behind the rest of the world, you can then achieve huge growth rates by simply starting to catch up. Hong Kong companies, for example the telecom and power companies, used to give their old, obsolete equipment to Chinese comapnies. China could take a one-decade leap in techonological development overnight by simply replacing 1950s technology with 1960s technology, but there are only so many of those leaps one can take, and then growth slows down. And they had to grow at high rates for many years to claw their way back up to where they were in the late 1940s.

So, the growth rate after a war is largely replacing things that have been lost, and it's usually accomplished through a lot of debt that has to be paid back eventually (or financed forever). Plus, of course, the economy before WWII was the Great Depression, so it would have been hard for things to be worse afterwards.

Did the war take the USA out of the Great Depression? Or was it that after the war, they cut back on the government programs that had prolonged and deepened the depression in the first place?

The person who commented on North Korea is on the right track, in my opinion. I think one could make a perfectly valid economic argument that sometimes some creative destruction is needed in order to improve long-term economic growth.

For example, if the reconstruction activity improves trust between people, and increases the desire and willingness to cooperate and exchange, there could be a significant improvement in institutions, and hence a decline in transactions costs, that could increase the long-term growth rate of the economy. Given compounding, it is quite possible that the benefits of the tsunami in could vastly outweigh the counter-factual in which no destruction took place.

Yes, there are costs to the destruction that takes place, but isn't it possible that the alternative could bring such gains, and that those gains could be so permanent, that the tsunami could actually bring economic benefits?

I certainly think so.

If someone took $250 out of their savings to replace a broken window, that's money that isn't there for the bank to loan to someone starting or expanding a business, buying a house, etc.

Then why do so many economists suggest that that is exactly what Asians and Europeans need to do in order to increase domestic consumption? (At least that's my interpretation. Do economists mean something else when they talk about spurring domestic consumption?)

s:

Yes, but these positive effects could have taken place in the absence of the tsunami. The tsunami could, I suppose, spur faster movement toward, say, the intangible "trust between people, and ... desire and willingness to cooperate and exchange" that you mention, but even if (big "if") I were to stipulate that the short- to medium-term economic impact could be outstripped by a faster rate of economic development for the long term, I can't concede that it would outweigh the human cost.

Positive effects from a disaster, it seems to me intuitively, are only incidental. A tsunami is not "creative destruction." It's purely destructive destruction.

Tom,

Economists who are asking for more domestic consumption are not (or at least should not) necessarily talking about increasing domestic spending. In fact the japanese who instituted massive public expenditure programs to do just that were still not able to spend their way out of recession. Rather, they are talking about reorienting spending away from creating export dependent industries. Many policies, in Asia especially, are export friendly and import averse, including puposeful propping up of the dollar, etc. However, I find much of this domestic consumption stuff a little silly as well. Bastiat is right, many economists are wrong. The current account issue is far more complicated than the Chinese not spending enough.

It seems to me that an easy test is just to ask, if destruction (hurricanes, tsunamis, wars) is so good for the economy, then why don't we just have an official government destruction team, that goes from town to town every few years and demolishes buildings at random? Why should Florida get all the economic boom. The official government destruction team would be GREAT for the economy, right?

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